Analysis by Bloomberg Intelligence Economics suggests a drop in the yuan to 7.70 to the U.S. dollar could return export growth to 10% year on year by end-2016 and add 0.7 percentage point to GDP growth. A slide to that level could also result in capital outflows of around $670 billion, though that appears manageable given the People’s Bank of China’s large foreign exchange reserves.

Eoin Treacy's view

As I discussed yesterday China needs a weaker currency and the question is really in what way it is going to achieve that goal. Despite that fact, the last thing the administration wants is to engender panic so it is reasonable to expect some measures to support the currency will be implemented to allow the short-term oversold condition to be unwound. 

The Offshore Renminbi shows evidence of such a move today but a sustained move below the 200-day MA would be required to question the Dollar’s medium-term dominance. 

As long as the Chinese were allowing their currency to appreciate against the US Dollar, its regional competitors were under less pressure to hold back their currencies from appreciating. This created a benign environment for foreign investors who had the benefit of rising currencies, high growth market and the potential for an attractive yield. 

China’s devaluation of the Renminbi changes those dynamics. Foreigners are now taking money out and domestic firms that had borrowed in Dollars, in the hope of paying back in an appreciating currency, are in trouble. As if to add insult to injury China’s economic slowdown is having a knock-on effect regionally resulting in downward pressure on currencies. 

The Asia Dollar Index extended its downtrend yesterday but steadied somewhat today as the Renminbi found some respite. There is potential for some additional steadying as the short-term oversold condition is unwound but a sustained move above 109 would be required to begin to question the medium-term downward bias. 

The South Korean Won in particularly is worthy of mention. The Dollar has held a progression of higher reaction lows since 2014 and rallied this week to retest the upper side of the five-year base. It may pause in the region of KRW1200 but a sustained move below the trend mean would be required to begin to question medium-term potential for Dollar dominance. 

Amid what is a panicky environment it is worth remembering that once currency devaluation has run its course the competitive advantage gained from the decline will be reassessed and investors will be enticed to participate once more.